Brandywine Joins Funds Seeking Yield From Spain to IHOP

Spain's economy expanded last quarter at its quickest pace since 2007, beating Germany for the first time in five years. Photographer: David Ramos/Bloomberg

Aug. 18 (Bloomberg) -- Tracy Chen, a portfolio manager at
Brandywine Global Investment Management LLC, kept her eye on
Spanish mortgages for three years. Once labor productivity hit
her target in January as Spain’s economy began to accelerate,
Chen seized her chance.

Chen has kept buying through this month, swapping some of
her Legg Mason BW Alternative Credit Fund’s holdings of non-agency U.S. residential mortgages for mortgage-backed securities
in Spain, Greece and Portugal as those markets stabilize. The
bets helped the fund win the No. 2 spot for performance in 2014
among non-traditional bond funds, according to Morningstar Inc.

“The European trade is still in the third or fourth inning
while the U.S. non-agency trade is in the seventh or eighth,”
said Chen, who’s managed the fund since its inception in August
2010. “There were so many more opportunities in 2010, but now
non-agency prices are much higher and the market has become so
much more efficient.”

Managers at Brandywine, Western Asset Management Co. and
other funds are evaluating and shifting some of their holdings
of U.S. mortgage-backed bonds to other asset-backed securities.
The rally in mortgage bonds that aren’t insured by the
government has slowed as the housing market has recovered from
the 2008 crash. So everything from securities tied to pools of
student loans to fees franchisees of restaurants like IHOP pay
parent companies are luring investors as issuers push sales to
the highest level in five years.

Subprime Auto

Returns are shrinking on the riskiest non-agency mortgage
bonds, or subprime. Investors reaped gains of 41 percent in 2012
compared with 17 percent in 2013, according to Barclays Plc
index data. This year through Aug. 14, the debt returned about
10 percent, the data show.

Buyers of mortgage-backed securities also face fewer
opportunities. Deals tied to new non-agency loans were about $4
billion this year, according to data compiled by Bloomberg.
Sales peaked at $1.2 trillion annually in 2005 and 2006.

Some money managers have been shedding their mortgages with
government backing this year in anticipation of the end to the
Federal Reserve’s bond buying program, which could cause prices
to fall, said Matt Jozoff, an analyst at JPMorgan Chase & Co.
Some of that money is going into Treasuries and asset-backed
securities with higher yields, such as student loans and
subprime auto debt, Jozoff said.

Spanish Mortgages

Brandywine’s Chen increased her fund’s exposure to Spanish
mortgages and other European asset-backed securities to about 70
percent as of July 31. She said she likes certain Greek
mortgages because borrowers are mostly public employees whose
payments are deducted directly from their salaries.

Spain’s economy expanded last quarter at its quickest pace
since 2007, beating Germany for the first time in five years.
Greece’s economy contracted at its slowest pace in almost six
years.

“The underwriting standards in Europe are still more solid
than they were in the U.S.,” said Chen, whose Philadelphia-based firm is a subsidiary of Legg Mason Inc. and oversees $58
billion in assets. “Most of the quality in Europe is what we
would consider prime. So we can achieve higher returns with less
risk.”

Chen’s $188 million fund returned 9 percent this year
through July 31 and an annualized 21 percent since inception
four years ago, Bloomberg data show. The fund’s 2014 returns
earned it the second spot, behind the Cedar Ridge Unconstrained
Credit Fund, among 86 non-traditional bonds funds tracked by
research firm Morningstar.

Student Loans

Private student loans to borrowers with higher credit
scores are attracting money from Western Asset. U.S. student
loan debt totals more than $1 trillion.

By focusing on less risky loans, even if the economy slows
down, fewer of those borrowers will default, said Anup Agarwal,
head of mortgage and asset-backed securities at Pasadena,
California-based Western Asset. The firm manages $469 billion in
assets and is the biggest bond unit of Legg Mason.

While the firm still has significant investments in non-agency mortgages, there are better returns to be made in student
and small business loans made by private lenders, Agarwal said.

“We keep looking for areas where the banks used to lend
and aren’t really doing it anymore, so there are private lenders
filling in,” Agarwal said. “That’s where the more attractive
pricing is.”

Esoteric Securities

More traditional asset-backed securities like autos and
credit cards offer low yields and aren’t worth investing in
right now, said Brad Friedlander, co-founder of Angel Oak
Capital Advisors LLC in Atlanta. He said he prefers a
supplemental allocation to more esoteric securitizations whose
return of principal aren’t correlated to the movements of other
holdings in his $2.8 billion Multi-Strategy Income Fund.

Friedlander reduced the agency mortgages in the fund to
zero this year, increasing its cash holdings and diverting some
of it to non-agency mortgages, commercial mortgage-backed
securities and non-traditional asset-backed securities.

“The fund is designed to play relative value among all
these spaces -- CLOs, CMBS, ABS, even agency MBS,” said
Friedlander.

Angel Oak’s non-traditional asset-backed holdings include
pools tied to payouts from large insurance companies to
plaintiffs following court cases. Investors rarely suffer losses
and yields are as high as 5 percent, Friedlander said. He said
he also likes securitizations of the income streams from lease
payments made by solar panel buyers, especially deals from
SolarCity Corp., where billionaire Elon Musk serves as chairman.

IHOP Bonds

Some of the less traditional asset-backed securities
markets lack liquidity. That’s why John Kerschner, global head
of securitized products at Janus Capital Group Inc., started
focusing on more liquid whole business securitizations in the
last couple of months.

Firms such as DineEquity Inc., whose brands include
Applebee’s and IHOP, are offering securitized bonds this year
that are tied to the fees franchisees pay to the parent company.

The deals make sense for iconic brands that are expanding,
said Kerschner, who’s based in Denver and co-manages the Janus
Multi-Sector Income Fund. Deal sizes have also been attractive,
at about $1 billion, which means investors can buy a large block
of bonds.